On February 12, 2021, Alabama enacted HB 170 / Act # 2021-1. The new law makes several important changes to Alabama income taxes, including the following: formalizing the state’s treatment of Paycheck Protection Program (PPP) loans and related expenses in line with the governor’s prior proclamation, adopting a single-sales factor apportionment formula, addressing federal tax reform provisions that had caused issues for Alabama taxpayers and adopting an elective pass-through entity (PTE) tax regime similar to other states. The income tax reform is a mixed bag that will impact a wide range of Alabama taxpayers.
PPP Loan Exemptions and Deductions
HB 170 enacts the Alabama Taxpayer Stimulus Freedom Act of 2021. The new law codifies the governor’s previous proclamation and confirms that forgiven PPP loan income is exempt from Alabama financial institution excise tax and income taxes. Likewise, business expenses paid or incurred with PPP loan proceeds are deductible for Alabama tax purposes to the same extent they are deducted for federal income tax purposes. Lastly, the PPP loan amounts are excluded from the calculation of the Alabama federal income tax deduction. These provisions are effective for tax years ending after the date of enactment of the Coronavirus Aid, Relief, and Economic Security (CARES) Act (March 27, 2020).
Other COVID-19 related grants and assistance are also exempt from Alabama income taxes, including Small Business Association subsidy payments, emergency economic injury disaster loans (EIDL), targeted EIDL advances, and grants to closed venues. Amounts from the Alabama Coronavirus Relief Fund are not treated as income for Alabama income tax and financial institution excise tax purposes. A number of other COVID-19 related funds, tax credits, and grants are also excluded from state income taxes.
Alabama Business Tax Competitiveness Act
Alabama’s codification of the Multistate Tax Compact (an interstate compact, or agreement, that facilitates state tax uniformity, creates the Multistate Tax Commission and is currently enacted by 15 states and the District of Columbia) is amended to adopt two important and wide-ranging changes to Alabama’s income apportionment method. First, HB 170 eliminates Alabama’s three-factor income apportionment formula with double-weighted sales factor in favor of a single-sales factor apportionment formula. Second, the new law eliminates Alabama’s sales factor “throwback” rule, including for sales to the U.S. government. Therefore, sales of tangible personal property shipped from Alabama to a purchaser in another state where the Alabama taxpayer is not taxed and sales shipped to the U.S. government in Alabama or another state are no longer included in the Alabama sales factor numerator.
While the adoption of a single-sales factor formula should benefit capital and labor-intensive industries operating in Alabama that sell to customers outside of the state, service providers and businesses that sell tangible personal property or deliver services that are produced or performed outside of the state to Alabama customers could be negatively impacted by this change. Because their out-of-state property and payroll will no longer enter into the Alabama apportionment formula, these taxpayers will see an increase in income apportioned to the state. However, taxpayers that sell to U.S. government facilities and installations located in Alabama could benefit, because their sales will no longer be sourced to the state. These apportionment changes are effective for tax years beginning on and after January 1, 2021.
Conformity with Federal Tax Reform
Prior to HB 170, Alabama was one of a handful of states that had not addressed the Tax Cuts and Jobs Act (TCJA) global intangible low-taxed income (GILTI) regime. Although Alabama allows 100% deduction for subpart F income and foreign source dividends, that deduction did not apply to GILTI, as it was limited to subpart F income inclusion under Internal Revenue Code (IRC) Section 951. GILTI is an inclusion under IRC Section 951A. HB 170 rectifies this issue by enacting a new Alabama code section to provide a GILTI deduction, net of the federal Section 250 deduction, and net of expenses deducted for federal purposes that are attributable, directly or indirectly, to GILTI. This change is effective retroactively to tax years ending after December 31, 2017; however, no refunds will be paid with respect to tax years ending before January 1, 2020.
A Modified Approach to the IRC Section 163(j) Limitation
The new law modifies the state’s approach to the IRC Section 163(j) limitation of deductible business interest expense for Alabama taxpayers that are affiliated members of a federal consolidated group. A federal consolidated group member that files a separate Alabama return is allowed to avoid a state-level limitation if the group is not subject to the federal deduction limitation. If the group is subject to the federal deduction limitation, then an affiliate that is an Alabama taxpayer is required to compute a state-level limitation on a separate entity basis or, if applicable, on the basis of the elective Alabama nexus combined group. Despite this modified approach to the state-level limitation, the IRC Section 163(j) gross receipts exception is applied by Alabama on a separate entity basis.
In addition, the Alabama business interest expense deduction limitation (if applicable) is applied first before applying the Alabama related party interest expense add-back statute. Any limitation to deductible business interest expense at the state level is applied pro-rata to related party interest income recipients.
Taxpayers will be required to provide supporting documentation to the Department of Revenue. The modified Alabama Section 163(j) limitation is effective for tax years beginning on and after January 1, 2021.
Alabama Electing Pass-Through Entity Tax Act
Alabama joins other states by enacting its own version of an elective PTE tax, which allows eligible PTEs (i.e., Subchapter S corporations and Subchapter K entities) to elect to be taxed at the entity level. Electing PTEs are taxed at the highest Alabama marginal individual income tax rate calculated in accordance with the Subchapter K or Subchapter S rules, as appropriate, and apportioned in accordance with the state’s multistate apportionment rules. Unlike Maryland, New Jersey, and Rhode Island, the electing PTE owners do not receive an Alabama tax credit for their distributive or pro-rata share of the income tax paid by the PTE. Rather, the members are not liable for Alabama income tax that would otherwise be imposed on their distributive share of PTE income. The election is effective for tax years beginning on and after January 1, 2021.
The Alabama PTE tax election may be made at any time during the tax year or on or before the 15th day of the third month after the close of the tax year, for which the election shall be effective. The election is binding until revoked. Both the election and revocation must be made by the PTE’s governing body and by greater than 50% of the voting control of the entity.
Decoupling from IRC Section 118(b)(2)
The TCJA enacted IRC Section 118(b)(2) to treat certain state and local tax and business incentives (governmental entity contributions) as includible in federal gross income and no longer as non-shareholder capital contributions. HB 170 decouples from this federal income inclusion provision effective immediately.
Machen McChesney Insight
For more information about the above article or other business tax services, contact Michael D. Machen, CPA, CVA at (334) 887-7022 or by leaving us a message below.
This article originally appeared in BDO USA, LLP's Insights/Tax/State and Local Tax - January 2021. Copywrite 2021 BDO USA, LLP. All rights reserved. www.bdo.com.